Ever since the introduction of the 7.5% increase in the rate of tax on dividends in April 2016, it has been more tax efficient for owner managed business shareholders to pay interest on their loans to the company rather than pay themselves dividends.

The interest would be deductible against the company's profits saving corporation tax at 19% (was 20%), whereas dividend payments are not tax deductible. A higher rate taxpayer would end up with more post tax cash, despite the rate being 40% compared to the 32.5% rate on dividends.

The table below assumes that the shareholder is a higher rate taxpayer and has already taken a dividend of £5,000 tax free.

Company

Dividend

Interest

Profit

100

100

Interest

(100)

Crop. tax

(19)

Distribute

81

Individual

Dividend

Interest

Gross

81

100

Tax

(26)

(40)

Net

£55

£60

The above calculation also assumes that the shareholder has £500 of other interest so that the savings allowance has already been used. Note also that the company is currently required to deduct 20% tax at source and report the interest on form CT61.